10 4 Flexible Budgets Financial and Managerial Accounting

A flexible budget might be used, for example, if additional raw materials are needed as production volumes increase due to seasonality in sales. Also, temporary staff or additional employees needed for overtime during busy times are best budgeted using a flexible budget versus a static one. If, however, the cost was identified as a fixed cost, no changes are made in the budgeted amount when the flexible budget is prepared. Differences may occur in fixed expenses, but they are not related to changes in activity within the relevant range.

A flexible budget on the other hand would allow management to adjust their expectations in the budget for both changes in costs and revenue that would occur from the loss of the potential client. The changes made in the flexible budget would then be compared to what actually occurs to result in more realistic and representative variance. This ability to change the budget also makes it easier to pinpoint who is responsible if a revenue or cost target is missed. A static budget is one that is prepared based on a single level of output for a given period. The master budget, and all the budgets included in the master budget, are examples of static budgets. Actual results are compared to the static budget numbers as one means to evaluate company performance.

  • Instead, they have a massive amount of fixed overhead that does not vary in response to any type of activity.
  • Then, they can modify the flexible budget when they have their actual production volume and compare it to the flexible budget for the same production volume.
  • However, it is suitable when there is a probability of fluctuations in fixed costs.
  • For example, Figure 10.26 shows a static quarterly budget for 1,500 trainers sold by Big Bad Bikes.
  • At 80% capacity, the working raw materials cost increases by 5% and selling price falls by 5%.

For example, this article shows some large U.S. cities are faced with complicated budgets because of high fixed costs. A flexible budget often uses a percentage of your projected revenue to account for variable costs rather than assigning a hard numerical value to everything. This allows for budget adjustments to occur in real-time, taking into account external factors.

Advantages of Flexible Budgeting

Flexible budgets are best used for startups that have a number of variables such as manufacturing, and others that have revenue based on seasonality, as costs are directly impacted by demand. Flexible budgets are dynamic systems which allow for expansion and contraction in real time. They take into account that a business is an organic, growing system and that life is not predictable. After overview of key elements of the business each month (or set period) closes, you compare the projected revenue against the actual revenue and adjust the next month’s expenses accordingly. Even if a cost is assigned a numerical value, a monthly review of costs compared to revenue allows that number to be changed for future periods. We’ve previously covered the five different types of budget models that businesses can choose from.

Suddenly, there is only one company to meet demand for widgets, resulting in actual sales of 200 units per month. The actual revenue the widget company is taking in has doubled—but the production costs would also go up. For example, let’s say a company had a static budget for sales commissions whereby the company’s management allocated $50,000 to pay the sales staff a commission.

A flexible budget is usually designed to predict effects of changes in volume and how that affects revenues and expenses. In order to accurately predict the changes in costs, management has to identify the fixed costs and the variable costs. Fixed costs will be constant within relevant range of operations where the variable costs will continue to increase as production increases. A company wants to prepare a budget based on a scheduled activity level of 70% of the production capacity, where the number of units designed is 7000. The variable costs and fixed costs are $7,000 and $10,000, respectively.

Benefits of a Static Budget

With Mosaic, you can also import your financial statements from Excel, ensuring seamless integration and facilitating a more holistic view of your financial position. If you manage a high-level production environment, creating a flexible budget can help mitigate the typical variances found on static budgets. In a flexible budget, there is no comparison of budgeted to actual revenues, since the two numbers are the same. The model is designed to match actual expenses to expected expenses, not to compare revenue levels. There is no way to highlight whether actual revenues are above or below expectations.

What are the limitations of flexible budgeting?

NetSuite has packaged the experience gained from tens of thousands of worldwide deployments over two decades into a set of leading practices that pave a clear path to success and are proven to deliver rapid business value. With NetSuite, you go live in a predictable timeframe — smart, stepped implementations begin with sales and span the entire customer lifecycle, so there’s continuity from sales to services to support. Static budgets are often used by non-profit, educational, and government organizations since they have been granted a specific amount of money to be allocated for a period. Let’s face it  – business moves fast, and we have to be flexible for what is thrown at us. Mary Girsch-Bock is the expert on accounting software and payroll software for The Ascent. Harold Averkamp (CPA, MBA) has worked as a university accounting instructor, accountant, and consultant for more than 25 years.

Flexible budgets create an accurate picture of production costs

The ability to provide flexible budgets can be critical in new or changing businesses where the accuracy of estimating sales or usage my not be strong. For example, organizations are often reporting their sustainability efforts and may have some products that require more electricity than other products. The reporting of the energy per unit of output has sometimes been in error and can mislead management into making changes that may or may not help the company. A great deal of time can be spent developing step costs, which is more time than the typical accounting staff has available, especially when in the midst of creating the more traditional static budget. Consequently, the flex budget tends to include only a small number of step costs, as well as variable costs whose fixed cost components are not fully recognized.

It may be favorable (higher than it should have been for actual production activity) or unfavorable (lower than it should have been). For example, a widget company might start out the year with a static planning budget that assumes that the cost to produce 10 widgets is $100, and the company will produce 100 units per month. Each unit will bring in a net profit of $50, so the net profit per month will be 100 X 50, or $5,000. Static budgeting is constrained by the ability of an organization to accurately forecast its needed expenses, how much to allocate to those costs and its operating revenue for the upcoming period. When using a static budget, a company or organization can track where the money is being spent, how much revenue is coming in, and help stay on track with its financial goals. Variable costs are usually shown in the budget as either a percentage of total revenue or a constant rate per unit produced.

Flexible budgets make sense

While this isn’t a reason to avoid flexible budgeting altogether, it’s good to keep in mind as you consider how and when to implement this kind of budgeting strategy. If your company regularly conducts a flux analysis, syncing this process with your flexible budget creation can help save time. A flexible budget adjusts based on changes in actual revenue or other activities. The result is a budget that is fairly closely aligned with actual results. This approach varies from the more common static budget, which contains nothing but fixed expense amounts that do not vary with actual revenue levels.

Content: Flexible Budget

The difference between your projected and actual figures gives you the flexible budget variance, an essential metric to understand how well your predictions align with your actual performance. In an unpredictable financial world, flexible budgets are helpful in manufacturing industries where costs change with a change in activity level. Companies must involve experts to make accurate budgets, ensuring there is less scope for error and improving variance analysis. This approach varies from the more common static budget, which contains nothing but fixed amounts that do not vary with actual revenue levels. This means that the variances will likely be smaller than under a static budget, and will also be highly actionable. Flexible budgets calculate, for example, different levels of expenditure for variable costs.

Flexible budgets change based on fluctuations with variable costs and have the ability to expand or contract in real time. While creating and maintaining real-time adjustments can be somewhat time-consuming, there’s tangible value in terms of more efficient budget allocations and more agile decision-making. After each month (or accounting period) closes, a flexible budget assumes you’ll compare projected revenue to actual results and adjust the next month’s expenses accordingly.